Florida Real Estate Brokers Guide Sixth Edition Linda

Unit 15 Investment Real Estate

Basic Investor Situation • • Existing asset portfolio Liabilities Contingent liabilities Risk preferences Earning potential Real estate management capability Specific investment goals Investor’s experience, reputation, ego © 2017 Kaplan, Inc. 3

Basic Property Characteristics • Return • Risk level – Business risk – Financial risk

Rent Determination – Area determination – Determination of base rent charge – Percentage (overage) rent – Rent concessions – Expense stops – Pass-through expenses – Reimbursable vs non-reimbursable expenses – Expense caps – Pro-rata expenses © 2017 Kaplan, Inc. 5

BOMA Area Measurement Standards • Gross floor area – Total building area measured from outside walls • Rentable area (gross leasable area) – all the area inside tenant’s space • Occupant area (usable area) – area inside tenant’s space that the tenant uses • Rentable/usable ratio – Rentable area / usable area = load factor • Load factor (gross-up factor) – Occupant area x load factor = space for rent calculation © 2017 Kaplan, Inc. 6

Types of Leases • Gross lease-landlord pays all expenses • Percentage lease-Retail tenants pay a base rent plus percentage of sales over a preset threshold. • Net lease-Tenant pays taxes, insurance, and maintenance • Escalator lease-After certain expenses like taxes pass a preset threshold, the tenant pays the excess • Index lease-Lease payments increase based on an index 7 © 2017 Kaplan, Inc.

Options • • • Renewal option Expansion option Right of first refusal (ROFR) Right

Mortgages • • • Interest computation Balloon date Amortization term Other terms affecting the

Mortgages, Cont’d • Recourse provisions – Transferring mortgaged property • Legal priority of leases relative to mortgages • Prepayment Clauses • Estoppel letter for existing mortgage 10 © 2017 Kaplan, Inc.

Reviewing Structural Conditions • Roof should be professionally inspected • Heating, ventilation, and air conditioning (HVAC). Older systems need more service • Electrical—older systems may need upgrades • Insulation—check for asbestos • Utilities—separate meters for each unit • Storm drainage must conform to local rules • Internet services / bandwidth capacity © 2017 Kaplan, Inc. 11

Site Description • Land that is ready for a building is a site • Physical features include – Size, shape, topography, drainage, soil – Assemblage is use of more than one parcel – Plottage is the increase in value of the two taken as a whole • Access, road frontage, and visibility are important locational attributes • Legal restrictions such as zoning affects use © 2017 Kaplan, Inc. 12

Investment Property—Owner Data • Owner data to be verified – Deferred maintenance—high expense to correct – Understated reserves for maintenance – Rent concessions—occupancy rates unrealistic? – No management fees in owner’s statements – Short-term tenants—how many will leave soon? – Advance rent discounts—get estoppel letters – Tenants who own their own appliances 13 © 2017 Kaplan, Inc.

Financial Ratios Debt service coverage ratio Net operating income ÷ Annual debt service Operating expense ratio Operating expenses ÷ Effective gross income Expenses per square foot Operating expenses ÷ Total square footage Price per square foot Price ÷ number of square feet in property © 2017 Kaplan, Inc. 14

Financial Ratios (Cont’d) Break-even ratio Operating expenses – reserves + annual debt service Potential gross income Equity dividend rate Before-tax cash flow ÷ equity Capitalization rate Net operating income ÷ value Loan constant Monthly payment ÷ loan amount 15 © 2017 Kaplan, Inc.

Internal Rate of Return (Time Value of Money) • Accounts for change in cash flows over time • Adjusts values of cash flows depending on when the money is received • Discounts future cash flows to the present value • Uses after-tax cash flows in calculations 16 © 2017 Kaplan, Inc.

Types of Risk • Business risk—two types: – Static risk—from fire, flood, theft • Protect with insurance – Dynamic risk—from economic changes, tax code changes, etc. • Can’t be insured—requires due diligence before purchase • Financial risk – Mortgage payments increase risk © 2017 Kaplan, Inc. 17

Types of Risk • Capital risk – Can’t get financing when needed • Regulatory risk – Laws affecting use or taxation may affect value • Inflation risk – Return rates must increase at least as much as inflation 18 © 2017 Kaplan, Inc.